Definition
External Funds refer to the financial resources sourced from outside the company. These funds are typically obtained to finance operations, expand business activities, invest in new projects, or restructure existing debts. Common sources of external funds include bank loans, proceeds from bond offerings, and investments from venture capitalists.
Examples
- Bank Loan: A corporation may secure a loan from a bank to finance a new project or to cover ongoing operational expenses. The loan amount, interest rate, and repayment terms are typically agreed upon by both parties.
- Bond Offering: A company may issue bonds to the public as a means of raising capital. Investors purchase these bonds, lending their money to the company in exchange for periodic interest payments and the return of the bond’s face value at maturity.
- Venture Capital: Startups and growing companies often seek funds from venture capitalists who provide cash in exchange for equity or convertible debt, thereby fueling the company’s growth potential.
Frequently Asked Questions
Q: What are the primary advantages of external funds? A: The key advantages include the ability to finance new projects, expand operations, and leverage growth opportunities without depleting internal resources or needing immediate profitability.
Q: How does a company decide between different types of external funds? A: The decision typically depends on factors such as the cost of capital, impact on control (equity financing may dilute ownership), repayment terms, and the financial health and creditworthiness of the company.
Q: Are there any risks associated with obtaining external funds? A: Yes, risks include interest obligations (for loans and bonds), potential loss of control or influence (for equity financing), and the need to meet repayment schedules even during financial downturns.
Q: What is the difference between debt financing and equity financing? A: Debt financing involves borrowing funds that must be repaid with interest, such as through loans and bonds. Equity financing involves raising funds by selling ownership stakes in the company, such as issuing shares or receiving capital from venture capitalists.
Q: Can small businesses access external funds? A: Absolutely, small businesses can access external funds, although they may face more stringent qualifications or higher costs compared to larger corporations. Options like SBA loans, angel investors, and crowdfunding platforms can be viable sources.
Related Terms
Internal Financing: Financial resources that are generated from within the company, often through retained earnings, asset liquidation, or cost-saving measures. Unlike external funds, internal financing doesn’t involve debt or equity issuance.
Debt Financing: Raising capital through borrowing, which must be repaid over time with interest. Common forms include bank loans and bonds.
Equity Financing: Raising capital by selling ownership stakes in the company, such as through issuing new shares or receiving funds from venture capitalists.
Venture Capital: Funds provided by investors to startup or small businesses with high growth potential, typically in exchange for equity or convertible debt.
Online References
- Investopedia - External Financing
- Wikipedia - External Financing
- Corporate Finance Institute - Types of Financing
- The Balance - External Financing for Small Businesses
Suggested Books for Further Studies
- Corporate Finance: A Focused Approach by Michael C. Ehrhardt and Eugene F. Brigham
- Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions by Joshua Rosenbaum and Joshua Pearl
- Financial Management: Theory & Practice by Eugene F. Brigham and Michael C. Ehrhardt
- Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist by Brad Feld and Jason Mendelson
Fundamentals of External Funds: Corporate Finance Basics Quiz
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